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Written by Mark Sullivan, PARTNER; Darryl King, PARTNER; on May 1st, 2012.

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Will I make a difference or will I lose my shirt?

The recent recession has brought about a sea change in the way that we look at the role of a company director and directors’ liability. It is no longer seen as a comfortable position of power and control but it attracts the real risk of personal liability for a director. In addition, proposed changes to company law criminalise breaches of certain directors’ duties in an effort to increase accountability and protect investors. It is prudent for directors to undertake a health check and seek advice in relation to their responsibilities.

In prosperous times little attention is given to those in positions of responsibility. It is a little like being a rugby coach. The coach’s profile is raised when the team is not doing so well and the coach is often the one most criticised.

Directors need to be careful in the way they govern a company in prosperous times. However, they need to be even more careful during times of difficulty. It is during the difficult times when directors tend to take the greatest risks, and those decisions can give rise to personal liability. There are a number of legal avenues that a liquidator, receiver, the IRD or other creditor might pursue against a director. You may well be surprised by the willingness of the courts to find a director personally liable and require the director to dip into his or her own pocket to pay the company’s creditors. As you will see from the paragraphs below, proposed new legislation is also seeking to criminalise serious breaches of certain directors’ duties.

Criminal liability for breach of director duties

The Companies and Limited Partnerships Amendment Bill, introduced late last year, will (amongst other things) criminalise breach of two of the existing duties in the Companies Act:

the duty to act in good faith and the best interests of the company; and

the duty not to agree to, or cause to allow, company business to be carried out in a manner likely to create a substantial risk of serious loss to the company’s creditors.

Under the Bill a director will be criminally liable if he or she knows that his or her breach of these duties is either seriously detrimental to the interests of the company, or would result in serious loss to the company’s creditors. Breach of either offence could result in penalties of up to five years’ imprisonment or a fine of up to $200,000.

The requirement for actual knowledge means that a prosecutor will need to prove that a director actually knew or was willfully blind to the fact that his or her actions would be seriously detrimental to the interests of the company, or would result in serious loss to the company’s creditors. This will be difficult to prove, and by setting the bar this high, the government is trying to ensure that the Bill will not deter people from becoming directors.

Reducing your risk

To reduce the risk of attracting personal liability, a director needs to “tick all the boxes” and seek professional advice where appropriate. For example, there is often a temptation to prefer one creditor over another because that creditor is applying the most pressure, threatening legal proceedings or withholding supply. Often a decision is made to solve an immediate problem but it has (often unintended) consequences for another creditor. It is in the difficult times that directors should seek professional advice from a lawyer with specialist knowledge in this area.

It is also timely that directors review their insurance policies. There are different policies in the market. In several recent finance company cases, the courts have frozen the insurance.

fund due to the wording in one policy. This is being contested but the sharp consequence is that the directors have had to personally fund the legal defense costs. That can put the director at a significant disadvantage and add to the stress of having to defend legal proceedings.

This short note is not intended to be alarmist but to signal that the playing field has changed for directors. All of the signals suggest that there is going to be increasing scrutiny of directors in their roles and a greater appetite for pursuing directors personally in the event of financial losses. There are a number of things you can do to improve your position and reduce the risk including obtaining a written indemnity from the company, obtaining robust insurance and most importantly seeking professional legal advice when important decisions are made.